Angela Merkel is Bluffing

Sebastian Niedlich, Flickr.

Sebastian Niedlich, Flickr.

SODOM & GOMORRAH: Angela Merkel’s panel of economic advisors have criticized the German Chancellor’s efforts at expanding the European Commission’s control over member-state budgets. Calling it politically improbable, the group claims that Merkel’s efforts have no hope of realization. Perhaps that’s the point.

I mentioned this in June: the European Union has two choices going forward. Either the EU tightens its grip on member-states or it dissolves. In the current crisis, there is no middle ground.

Individual interests are too varied for consolidation. The financial crisis is simply too large for any of the Eurozone leaders to sort through, much less understand. Each member-state has an immediate interest in saving itself from the crisis, and these efforts usually involve relying on a larger, more stable country to bail them out. As the bad debt changes hands, the risks compound and everyone is damaged.

Up to this point, much of the bailing out has been done by Germany, the country most conscious of the moral hazard involved with bailouts. Germany has also been under pressure by several outside forces to do more to promote jobs and economic growth – in other words, adopt an inflationary policy, which they have been firmly opposed to.

And now Angela Merkel’s incredible proposition: allow the European Commission to veto individual member-state budgets when they get out of line. Several countries immediately turned their nose at the idea; bailouts are fine, but the whole point of a bailout is to avoid accountability. If an alliance comprised of Germany and other influential European countries could enter at any time and impose austerity measures, that would be, in the words of Merkel’s advisors, politically improbable. In a word, it would be a disaster. Individual politicians would be thrown out of office for surrendering their sovereignty to outside powers who would force strict austerity measures on any country seeking a bailout.

Angela Merkel is bluffing. She wants to force the issue now so that the EU either strengthens to the point that she could take draconian measures on irresponsible members, or so that the organization stops pressuring her country into bailing everyone else out. It is, in short, a brilliant move.

Retail Purchases in the US Continue Decline

b00nj, Flickr.

b00nj, Flickr.

SODOM & GOMORRAH: Bloomberg news reports that retail sales in the United States “unexpectedly” decreased by 0.5% in June. Unexpected by whom?

For the third straight month, the US Commerce Department reported that retail purchases have fallen. The 0.5% decrease in June was greater than the 0.2% decline seen in May. Bloomberg News reports that this is an “unexpected” decline since they wrongly forecasted a 0.2% rise in June.

The job market continues to put a strain on US households. Retailers such as Target, Macy’s, JC Penney, and others have had a difficult time keeping up with shareholder expectation. Sears has been particularly hit hard by some of the developments in the retail market. In 2012, they have thus far posted a -7.51% profit. While Q2 earnings were a slight positive, the retail giant continues to struggle with its finances as it attempts a number of spin-offs.

“People are just pulling back,” noted Michael Carey, the chief economist for North America at Credit Agricole CIB in New York.

The surprise at the report and the misguided forecast are proof positive that mainstream economists exist only to make astrology look like a legitimate field of study.

It’s Not a Choice Between Inflation and Depression

Will Manley, Flickr.

Will Manley, Flickr.

SODOM & GOMORRAH: The German chancellor Angela Merkel is one of the few world leaders who isn’t being completely idiotic about the financial and economic crisis brewing in Europe. Much to the ire of others, Merkel has resisted political pressure to adopt a more inflationary policy because she feels it would be bad for Europe. The Economist has recently joined her list of critics.

In this week’s Charlemagne, the British paper argues that Merkel is misreading history. The hyperinflation under the Weimar Republic left a deep scar on the German psyche; the moral that is preached is that hyperinflation was the result of an insane policy and that economic chaos created political instability and a second world war. A sound monetary policy is key to avoiding a similar outcome.

The Economist argues that hyperinflation didn’t lead to Hitler’s rise to power, but depression and mass unemployment did. Hitler’s Keynesian-like policy of building freeways and rearming Germany solved the problem, so the story goes.

There are two flaws with this argument.

First, it’s a little disturbing that such an intelligent paper can, without cringing, point out that Hitler independently came up with a Keynesian theory of economic stimulus and that modern Germany, Europe, and the rest of the world should follow suit because it worked. There’s a problem when your policy recommendations follow Hitler’s lead. I would also argue that the wanton destruction unleashed by World War II and the Holocaust probably resulted in a net decrease in Germany’s economic position when all was said and done. But even if it did work out, I think that cheaper pharmaceuticals do not justify using slave test subjects to produce them. I know controlling the cost of health care has always been a concern, but there’s more to politics than money.

Second, and in line with the argument that there’s more to it than money, I find the claim that economic conditions created fascism is very shallow. The existence of even one martyr proves that humans are not a couple of missed meals away from genocide. The existence of a human history that included economic hardship without a holocaust proves this as well.

Other factors create insane ideologies. I suspect that modern society’s shallow insistence that money is at the root of all action probably isn’t helping.

On the economic side, Merkel is correct to fight inflation. It’s not a choice between inflation and depression; inflation creates depression. Neither inflation nor depression create fascism, though, but that doesn’t take away from the fact that inflation and depression are painful.

The Euro Will End With Both a Bang and a Whimper

World Economic Forum, Flickr.

World Economic Forum, Flickr.

SODOM & GOMORRAH: The European Union continues in its path toward eventual dissolution. Eurozone leaders were divided and confused at yet another Brussels summit on the economy.

The Economist points to two solutions for the European Union. On one hand, Europe could strengthen its ties and erode more of the sovereignty of individual member-states while distributing wealth to poorer parts of the union. On the other, the EU could separate.
Superstate is Super Stupid

Individual interests are far too diverse in the European Union. I have been predicting for months that the Euro and, almost by extension, the EU won’t last through 2012. The financial crisis that the Eurozone faces is far bigger than any one or even a group of individuals. It’s simply beyond their capability to deal with. One may rightly suggest that the leaders are in many respects too stupid to adequately respond. But even if they were geniuses, I would argue that the complexities and different currents driving the crisis are too big for any governmental body to handle.

The EU made a critical mistake in making their union about economics instead of about a shared European identity. Granted, the idea of “Europe” as a singular, yet diverse whole, has been a driving force behind much of the popular support for the union, it isn’t the primary focus. It seems instead that the broader policy goals have always been about free trade between member-states, a shared currency, a unified monetary policy, and a foreign policy designed to protect members while carefully vetting new members so as to preserve the favored status of larger parties.

Economic unions work well when the economy is booming. During a period of decline, the selfish ties that brought everyone together tend to drive them apart in new ways.

There has been increasing pressure on Germany to do more to promote jobs and economic growth, but the Germans are strongly against any inflationary measures. No one has adequately been able to deal with Greece’s collapse. Very few can suggest any plausible course of action to stop Italy, Spain, and Portugal from following their Mediterranean neighbor’s lead toward bankruptcy.
Independence Day

Any plan to strengthen the EU is simply a plan to hold every member-state hostage to the crisis. Germany has the sanest plan; manage the deficit as best as possible, avoid inflation, let things correct as best as possible.

To force Germany, thus far a huge industrial powerhouse in Europe, to shoulder the burden of trying to bail every irresponsible European country out of the crisis will only condemn the Germans to a similar default.

Chancellor Angela Merkel is right to oppose mutualization in any form. The only way Europe stands a chance of surviving is if they abandon the idea of the EU. Merkel is the most level-headed leader of any large European power, but she may be powerless to stop the crisis from running to its worst possible outcome – after all, it is much larger than she is.

The Greece Default is Here

archer10 (Dennis) Busy, Flickr.

archer10 (Dennis) Busy, Flickr.

SODOM & GOMORRAH: It’s happened – despite all the hand-wringing, apologizing, and bailing out, the Greece default has happened.

Late Friday, a group of dealers in credit default swaps decided that Greece’s recent bond swap constituted a “credit event”. The yes vote by the International Swaps and Derivatives Association entitles holders of Greek credit default swaps to approximately $3.2 billion. A credit default swap is an insurance policy that can be taken out if a bond issuer defaults.

The Greece default was preceded by a bond swap deal that forced bond holders to take significant losses on the return of their money. The swap, approved by roughly 84% of bond holders, triggered the Collective Action Clause which forced the ISDA to decide that Greece has created a “credit event.” The ISDA defines three types of events: bankruptcy, failure to pay, and a restructuring according to Gavan Nolan a credit analyst at Markit. The Greek restructuring is tantamount to a default since the Greek government has basically acknowledged that it can’t pay bond holders the money they’re entitled to.

Nolan downplayed the event, saying that $3.2 billion was much smaller than expected and that the event is likely to be over-exaggerated.

We have yet to witness a wide-scale default such as this. Far from being exaggerated, the Greece default and the triggering of credit default swaps signifies the beginning of the end for Greece, the Euro, and any myth of stability we’ve seen thus far in the international financial markets. We’re all about to be screwed.

A Currency to Rival the Euro

Davide "Dodo" Oliva, Flickr.

Davide “Dodo” Oliva, Flickr.

SODOM & GOMORRAH: The first cracks begin to appear in the Eurozone; financially distraught Iceland considers adopting a new currency.

The Economist reports that Iceland is debating whether to move away from the krona and adopt a different currency. Canadians are likely to be thrilled by the idea, since the current proposal is to use the Canadian dollar (known as the Loonie). The move bolsters the Conservative government’s claim that the Canadian economy is one of the strongest in the world.

Alan Bones, Canada’s ambassador to Iceland said on March 2nd that his government was open to discussing the idea, yet thus far there has been a lack of real consideration for the move. Some politicians in Iceland suggest that the move was a ploy to get Iceland to discuss alternatives to joining the European Union and, thus, adopting the Euro as its currency. The Canadian government was also pretty quick to back away from Bones’ initial suggestion.

Current polls show that 70% of Icelanders are in favor of moving away from the krona but that they were evenly split over whether the Euro or the Loonie should be adopted. Since both countries share a geopolitical interest and Canada has thus far avoided some of the default woes that Europe has been facing, it will be interesting to see what Iceland chooses to do. I feel that the debate shows a real desire for alternatives to the Euro; ploy or not, the idea is gaining some traction and might be worth investing energy into. Economists who have analyzed the situation say that there are very few technical obstacles to adopting a currency such as the Loonie since it is well know.

Three Digitization Trends That are Disrupting Publishing and Media Industries

oliverlindner, Flickr.

oliverlindner, Flickr.

SODOM & GOMORRAH: Some very exciting things are taking place in technology. These developments are making it easy for disruptive, non-mainstream sites and views to be more accessible. Let’s take a look at three primary trends that are reshaping the content industry.
1. E-Readers and Tablets

The PC put a computer on every desk in every office and home. However, the reading experience was somewhat formalized. One usually had to go to the desk, at least until the development of lightweight laptops. But even those devices take up more space than is always convenient. With the development of low-cost tablet PC’s and e-readers, the content industry is forced to contend with truly personal devices.

E-readers disrupt traditional publishing models by how easy they make it to transfer content. Old publishing companies had to forecast potential book sales before going to print, making the industry very heierarchical. The barriers to entry often forced out smaller, lesser known writers and led to a virtual cartelization as publishers determined who published and how many books were printed. It also led to a situation of fairly strict price controls; publishers would decide on the price of a book and retailers would comply. E-readers changed that because the cost of production dropped so significantly. The only barrier is the one-time cost of digitizing the work and reformatting it in a way that works with e-reader software. Smaller authors can publish, larger authors can no longer charge as much for their works. While many publishers are still insisting on the old pricing model, it’s not likely they’ll be able to do so forever.

Tablets have done a similar thing to online media. The numbers show that more people use tablets during the hours when they’re home than they do other devices. The iPad, the Samsung Galaxy, and a score of other gadgets are invited into the home and into more relaxed settings. Content is often more intimate, since it must literally be touched in order to be consumed.
2. Free Technology and Content

Most online news sources have been placing their content behind paywalls. They’ve done this because they cannot support themselves on advertising revenue alone. The reason why advertising revenue has fallen so dramatically in recent years is painfully obvious: the news has become irrelevant. If newspapers had something interesting to say, they would have plenty of pageviews and plenty of advertisers to fill the space. The paywall model is a temporary fix that relies on squeazing more money out of people who are invested in the newspaper regardless of quality – business owners, lawyers, politicians, people ignorant of other information sources, etc. It falls apart the instant a free alternative emerges.

And they are emerging. This article hints that newspapers are blissfully ignorant of the independent publishers about to rain on their parade. With very little overhead and surprisingly relevant things to say,
3. Personalization

The rise of social-reader applications mean that content is being displayed based on personal preferences. People are getting more of what they want and they’re getting it more easily. With improving search engine algorithms and an increased interconnectivity between people with like interests, people are able to personalize their content more than they could before. We are living in a time when people grab a camera and make a documentary on their own, instead of waiting for a major news outlet to do so.

Five European Countries Downgraded by Fitch Ratings

jurjen_nl, Flickr.

jurjen_nl, Flickr.

SODOM & GOMORRAH: Spain, Italy, Belgium, Slovenia, and Cyprus were downgraded by Fitch Ratings. The agency claims that the Eurozone countries lack the appropriate financial flexibility to deal with the regional debt crisis. Surprise.

Italy was cut two points from an A+ rating to an A-. Spain was also lowered two points from AA- to A. Belgium was slashed from AA+ to AA. Slovenia found itself facing the same cut as Spain. Cyprus was pared to BBB- from BBB. The countries may be downgraded again within two years.

Fitch warned Europe about the pending downgrades last month when negotiations about Greek debt came to an impasse. The rating agency doesn’t feel that Europe is capable of handling the financial panic that would follow a default by a larger country such as Greece. Fitch’s report said, “The divergence in monetary and credit conditions across the euro zone and near-term economic outlook highlight the greater vulnerability” that would come from financial shocks. “These sovereigns do not, in Fitch’s view, accrue the full benefits of the euro’s reserve-currency status.”

The report was followed by some hand-wringing and apologizing from law makers in various parts of the world. European leaders are scheduled confer about future conferences on January 30th in Brussels.

The Rise of State-Owned Enterprises

Flag of the East India Company, post 1801.

Flag of the East India Company, post 1801.

SODOM & GOMORRAH: A special report in this week’s Economist on state-owned enterprises in emerging markets validates one of my theories – classical, small-state liberalism eventually morphs into the modern, welfare-state governments that we see today. The moral is that any time material interests dominate the political, the former will eventually use tools of coercion to force out rivals.

In the 1990′s with the fall of the Soviet Union, it was thought that state owned enterprises in emerging markets would eventually be dismantled in favor of more open trade systems. However, they don’t seem to be going away. As the Economist reports, the world’s ten largest oil and gas companies are state-owned and state-backed firms make up 80% and 62% of China’s and Russia’s stock markets respectively.

Brazil, South Africa, and other emerging countries are considering similar models. Supporters of state capitalism argue that it can provide stability and growth to an otherwise unstable free market. Infrastructure would especially be benefited because the state can quickly mobilize resources for large scale projects. Arguments in favor of state-owned enterprises have generally relied on the belief that some activities of public importance can be done most efficiently when one firm manages the market.

We are seeing a few developments.

First, emerging markets are opting toward state capitalism instead of toward a more free market model. They are marrying politics with economics in order to try and take advantage of diminishing returns.

Second, state-owned enterprises are being consolidated. Governments are being very selective in which state-backed firms they allow to survive. This means the overall number of firms has shrunk, but the size of the ones that remains has grown.

Third, state-owned enterprises are becoming more productive. In China for instance, the return on assets for government-owned companies has increased from 0.7% in 1998 to 6.3% in 2006. However, this is mainly because the government companies are better at copying what the private sector does than because of any real economic advantage.

I would argue that the growth of state-owned enterprises in emerging markets shows us our future. The vested interests of the heirs of the classical liberal tradition aren’t as prevalent in these countries. Instead we see modern politicians who are free to carry out the promise of their ideologies with very little opposition. The Economist would have you believe that this is the result of the current crisis of Western free market liberalism. Yet they overlook the fact that liberalism is the crisis; what we’re seeing in the West are the birth pangs of what’s already coming to be in emerging markets.

The Greek Debt Crisis Worsens

PIAZZA del POPOLO, Flickr.

PIAZZA del POPOLO, Flickr.

SODOM & GOMORRAH: The European Union continues to struggle to cope with the massive financial blackhole that is Greece. In short, default is both inevitable and the only real solution.

In December, the International Monetary Fund reviewed the Greek economy and released a set of findings that shows how impossible any easy fix will be for the Mediterranean country. The IMF states that even if almost every private creditor decided to write off half of what’s owed to them, Greek debt would still stand at a staggering 120% of GDP by 2020. It’s more likely that creditors will agree to write off a significantly smaller portion; another debt restructuring would be necessary in the future.

Up to this point, the EU has refused to consider default an option, but with the numbers looking the way they are it is basically an inevitability. And with the European Central Bank being, quite likely, the largest holder of Greek debt, such a default would impact the rest of the economic coalition.

What’s being discussed now is “Private-Sector Involvement” (PSI), which is nothing more than a plan to impose all the losses on the private creitors rather than the governments that hold these bonds. It isn’t likely that any deal will avoid Greek default and the governmental organizations that hold these bounds will eventually eat the losses. The Euro probably won’t survive 2012.

In response to the massive overspending that governments like Greece have undertaken in recent years, the Eurozone is currently debating a new treaty that would impose stricter budget rules on member-states. Under the treaty, European governments could sue each other in the European Court of Justice if they suspect one another of failing to work to keep their deficits within the new limits. If the accusing state wins, the court could impose a fine of up to 0.1 percent of the losing state’s GDP, which would be paid into the Eurozone’s new bailout fund.

EU leaders are set to discuss such measures today.